Edited version of your written advice

Authorisation Number: 1012920376169

Date of advice: 10 December 2015

Ruling

Subject: Functional Currency

Question 1

Is the taxpayer, as the head company of an income tax consolidated group (TCG), eligible to choose an 'applicable functional currency' (AFC) for the purposes of working out its taxable income or tax loss under item 1 of the table in subsection 960-60(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

If the taxpayer, as the head company of the TCG, makes a choice under item 1 of the table in subsection 960-60(1) of the ITAA 1997, will its AFC be the foreign currency for the purposes of section 960-70 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

The income year ended XXXX

The scheme commences in:

During the income year ended XXXX.

Relevant facts and circumstances

The taxpayer (on a stand-alone basis) is an Australian resident company for income tax purposes.

The taxpayer is the head company of a TCG.

The taxpayer is ultimately owned by the parent of the global group.

The majority of the taxpayer's business sales are denominated in the foreign currency. Some operating costs are also denominated in the foreign currency. As a result, the currency to which the taxpayer and its underlying businesses is primarily exposed is the foreign currency, consistent with the ultimate parent of the global group.

The majority of sales and revenue streams of the TCG are denominated in the foreign currency.

As the business operations of the taxpayer are based in Australia, many of its day to day operating costs such as salary and wages, overheads etc. are denominated in AUD. However, some operating costs and some capital expenditure are also denominated in the foreign currency.

The taxpayer is required to prepare a financial report for each financial year under section 292 of the Corporations Act 2001 (Corporations Act).

The majority of the companies in the TCG:

• maintain both a foreign currency and AUD denominated ledger (a dual ledger system);

• generate their management accounts and any supporting schedules in the foreign currency; and

• use the foreign currency for group and local management reporting.

The TCG uses the AUD denominated ledger to facilitate local compliance (e.g. GST and WHT) and currently calculates taxable income (or tax loss) in AUD terms.

The majority of the accounts of the TCG including ledgers, journals, profit and loss accounts and balance sheets are denominated in the foreign currency.

The taxpayer, as the head company of the TCG, has not previously made a choice under item 1 of the table in subsection 960-60(1) of the ITAA 1997 to adopt a foreign currency as its AFC.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 960-60(1)

Income Tax Assessment Act 1997 section 960-70

Reasons for decision

Question 1

Election of functional currency

Subdivision 960-D of the ITAA 1997 allows certain entities or parts of entities that keep their accounts solely or predominantly in a foreign currency to choose that foreign currency as their AFC to calculate their annual net income, which is then translated into Australian dollars for income tax purposes.

Broadly, an entity's AFC is the sole or predominant currency in which it conducts its activities or business and keeps its accounts.

A choice to use a functional currency can only be made by the following entities:

• an Australian resident required to prepare financial reports under section 292 of the Corporations Act;

• an Australian resident carrying on a business through an overseas permanent establishment (PE);

• a foreign resident carrying on a business through an Australian PE;

• an offshore banking unit;

• an attributable taxpayer of a controlled foreign company; and

• a transferor trust.

Section 960-60 of the ITAA 1997 sets out, in items 1 to 5 of the table, details of the entities that can choose to use a functional currency, the use that may be made of the functional currency and the time when the choice takes effect.

Item 1 of the table in subsection 960-60(1) of the ITAA 1997 states:

Choosing to use a functional currency
Item	If you are:	you may choose to use the applicable functional currency to...	with effect from the start of...
1	an Australian resident who is required to prepare financial reports under section 292 of the Corporations Act 2001	work out so much of your taxable income or tax loss as is not subject to a choice made by you under any of the other items of this table	(a) if the choice you make under this item is a backdated startup choice (see section 960-65) - the income year in which you make the choice; or (b) in any other case - the income year following the one in which you make the choice.

Taxation Determination TD 2006/7 Income tax: can an Australian resident company required to prepare financial reports under section 292 of the Corporations Act 2001 make a choice to use the 'applicable functional currency' under section 960-60 of the Income Tax Assessment Act 1997, if it is the head company of a consolidated group? (TD 2006/7) states that the head company of a tax consolidated group can make the choice to use the AFC, as defined in section 960-70 of the ITAA 1997, under item 1 of the table in subsection 960-60(1) of the ITAA 1997.

Taxation Determination TD 2007/24 Income tax: is the 'applicable functional currency' for the head company of a consolidated group determined by looking at the 'accounts' of all the members of the consolidated group, for the purposes of item 1 of subsection 960-60(1) of the Income Tax Assessment Act 1997? (TD 2007/24) states at paragraph 5:

An Australian resident head company can make the choice to use the 'applicable functional currency' under item 1 of the table in subsection 960-60(1). However, such a choice by a head company will be effective only if there is a sole or predominant foreign currency (that is, other than Australian currency) in which the head company keeps its 'accounts', at the time it makes the choice.

The taxpayer is an Australian resident for income tax purposes and is required to prepare financial reports under section 292 of the Corporations Act.

The taxpayer, as the head company of the TCG, has not previously made a choice under item 1 of the table in subsection 960-60(1) of the ITAA 1997.

Accordingly, under subsection 960-60(1) of the ITAA 1997, the taxpayer, as the head company of the TCG, can make the choice to use the foreign currency as its AFC to work out its taxable income or tax loss.

The choice must be made in writing, as stated in subsection 960-60(2) of the ITAA 1997, and continues until a withdrawal of the choice takes effect, or, in the case of a resident taxpayer who is required to prepare financial reports under section 292 of the Corporations Act, until the end of the income year in which that requirement ceases (subsection 960-60(3) of the ITAA 1997).

Question 2

What is the AFC?

The AFC will depend on the factual circumstances surrounding the entity's operations.

The AFC in relation to a choice made under item 1 of the table in subsection 960-60(1) of the ITAA 1997 is defined in subsection 960-70(1) of the ITAA 1997 as follows:

If you make a choice under item 1 of the table in subsection 960-60(1) with effect from the start of a particular income year, your applicable functional currency for:

(a) that income year; and

(b) each later income year for which the choice is in effect;

is the sole or predominant foreign currency in which you kept your accounts at the time when you made the choice.

Accounts

Subsection 960-70(4) of the ITAA 1997 states that for the purposes of this section, 'accounts' means:

(a) ledgers; and

(b) journals; and

(c) statements of financial performance; and

(d) profit and loss accounts; and

(e) balance-sheets; and

(f) statements of financial position;

and includes statements, reports and notes attached to, or intended to be read with, any of the foregoing.

Sole or predominant

The Explanatory Memorandum to the New Business Tax System (Taxation of Financial Arrangements) Bill (No. 1) 2003 states:

3.54…Broadly an entity's applicable functional currency is the sole or predominant currency in which its accounts are kept….This aligns the commercial rationale for accounting in a foreign currency with the use of that currency for income tax purposes…

3.55 For Australian residents required to prepare financial reports under section 292 of the Corporations Act 2001, the applicable functional currency for the income year and each later year for which the choice is in effect, is the sole or predominant foreign currency in which the books are kept…

However, the term 'sole or predominant currency' is not a defined term in the legislation. Taxation Determination TD 2006/4 Income tax: can an Australian resident entity which keeps its 'accounts' predominantly in a foreign currency, choose to use that foreign currency as its 'applicable functional currency', where the entity is required to prepare financial statements in Australian dollars for statutory reporting purposes? (TD 2006/4) states at paragraph 10:

The test of whether or not a particular foreign currency is the predominant one in which an entity keeps its 'accounts' (as defined), is a quantitative one, as it involves an examination of those 'accounts' in terms of the unit of measurement used (see, for example, FC of T v. FH Faulding & Co Ltd (1950) 83 CLR 594).

TD 2007/24 provides that:

1. …For the purposes of item 1 of subsection 960-60(1) of the Income Tax Assessment Act 1997 (ITAA 1997), the 'applicable functional currency' for the head company of a consolidated group is determined by looking at the 'accounts' of all the members of the consolidated group - and not just at the 'accounts' of the head company.

2. Whether there is such a currency under this view will depend on whether there is one particular foreign currency that is the currency predominantly used for the basic record keeping of the consolidated group.

…

6. The single entity rule in section 701-1 provides that if an entity is a subsidiary member of a consolidated group for any period, it and any other subsidiary member of the group are taken for 'head company core purposes' and 'entity core purposes' to be part of the head company, rather than separate entities for that period. The intended operation of the single entity rule is to apply the income tax laws for these purposes to a consolidated group, as if it was a single entity being the head company.

7. Calculation of the head company's liability for income tax, where this involves an application of item 1 of subsection 960-60(1), will come within the meaning of 'head company core purposes' for the purposes of section 701-1. The single entity rule in this context, will therefore affect the meaning of 'applicable functional currency' in subsection 960-70(1).

8. Accordingly, the term 'you' in subsection 960-70(1) refers, in such a case, to the head company of the consolidated group, including as parts of that entity all of the subsidiary members for the relevant period. The term 'your accounts' in the subsection correspondingly refers to the 'accounts' of the head company and all of the subsidiary members for this period. Note that only the 'accounts' of entities within a group consolidated for tax purposes are considered. Thus, in determining whether there is a predominant foreign currency for a consolidated group, no reliance is placed upon any consolidated group 'accounts' that do not relate solely to the tax consolidated group.

Furthermore, paragraph 11 of TD 2006/4 states that:

In this respect, no one component of those defined as making up these 'accounts' takes on any greater or lesser weight in reaching this conclusion, which is essentially one of fact and degree. For example, if an entity kept a dual ledger system and two sets of journals (that is in both a foreign currency and Australian currency), while its management accounts were kept in a foreign currency - we would accept that, on a quantitative basis, the entity kept its 'accounts' predominantly in a foreign currency.

For an Australian resident making a choice under item 1 of the table in subsection 960-60(1) of the ITAA 1997, the AFC is defined in subsection 960-70(1) of the ITAA 1997 to be the sole or predominant foreign currency in which it keeps its 'accounts' at the time it made the choice.

Based on the facts, the TCG keeps its accounts predominately in the foreign currency, given the majority of the accounts (as defined in subsection 960-70(4) of the ITAA 1997) by number, are kept in this foreign currency.

Furthermore, the fact that the TCG maintains a dual foreign currency/AUD ledger system does not preclude the foreign currency from being the TCG's AFC.

Therefore, the taxpayer, as the head company of the TCG, is eligible to choose, under item 1 of the table in subsection 960-60(1) of the ITAA 1997, the foreign currency as its AFC, as defined in subsection 960-70(1) of the ITAA 1997, as it is the sole or predominant foreign currency in which it keeps its 'accounts'.